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1
Macroeconomics in the Global Economy Antonio Fatás
Session 7. Business Cycles. Labor Markets.
v Introduction to Business Cycles
v What causes recessions?
v Labor markets
v Unemployment
Macroeconomics in the Global Economy Antonio Fatás
What is the Business Cycle?
v The business cycle describes medium term fluctuations in the level of economic activity (GDP) around a long term trend
v The business cycle can only be understood starting from a
measure of the long-term trend of the economy (Session 4).
v The business cycle is an aggregate phenomenon. Most sectors, most variable are well described by the business cycle.
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Macroeconomics in the Global Economy Antonio Fatás
600
700
800
900
1000
1100
1200
1300
1400
1500
1600
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
UK GDP Potential
The Business Cycle
Macroeconomics in the Global Economy Antonio Fatás
How do we measure potential output?
1. Using statistical analysis and measuring the trend of real GDP.
2. Using a model that combines factors of production (labor, capital) and productivity to measure the potential of the economy if all factors are employed.
In both cases, actual output is seen as fluctuating around potential output (not just below). The difference between the two is what we call the output gap.
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Macroeconomics in the Global Economy Antonio Fatás
Output Gap
-9
-6
-3
0
3
6
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Germany Japan United Kingdom United States
% Difference between GDP and Potential (Trend) GDP 100*(Actual – Potential)/Potential
Macroeconomics in the Global Economy Antonio Fatás
Measurement and Definitions
0
3
0
Recession
Peak
Trough
Expansion
Eco
nom
ic a
ctiv
ity
4
Macroeconomics in the Global Economy Antonio Fatás
-15
-10
-5
0
5
10
15
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
US Business Cycles Growth rate GDP
Industrialization
Railroads
The Depression of the 1890s
World War I
World War II
The Great Depression
Oil Shocks
“New Economy”
Historical Record: The US Business Cycles
Great Recession
Macroeconomics in the Global Economy Antonio Fatás
Historical Record: The US Business Cycles
Exp
ansi
ons
Rec
essi
ons
Average duration of recessions
1870 1890 1910 1930 1950 1990 2009 1970
Average duration of expansions 29 months 50 months
21 months 11 months
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Macroeconomics in the Global Economy Antonio Fatás
-4
-2
0
2
4
6
8
1960 1966 1972 1978 1984 1990 1996 2002 2008
US GDP Growth
Historical Record: The US Business Cycles
Macroeconomics in the Global Economy Antonio Fatás
-4.5
-2.5
-0.5
1.5
3.5
5.5
1961 1967 1973 1979 1985 1991 1997 2003 2009
Euro Area GDP Growth
Historical Record: The Euro Business Cycles
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Macroeconomics in the Global Economy Antonio Fatás
-7
-5
-3
-1
1
3
5
7
9
11
1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Korea GDP Growth
Historical Record: The Korean Business Cycles
Macroeconomics in the Global Economy Antonio Fatás
The “Great Recession”: 2008-2009
-1
0
1
2
3
4
5
6
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
World GDP Growth
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Macroeconomics in the Global Economy Antonio Fatás
-6
-4
-2
0
2
4
6
8
10
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
GDP Growth
Advanced Emerging
Advanced Economies Led the World into a Recession
Macroeconomics in the Global Economy Antonio Fatás
Expansions always end because of an unexpected event (good luck forecasting them!) or because of accumulation of imbalances (or a combination of both).
In the post-war period recessions have been relatively short
and mild – from 6 to 16 months (in advanced economies).
Their length and frequency has been going down over time
(“The Great Moderation”).
Why do recessions occur?
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Macroeconomics in the Global Economy Antonio Fatás
2200
3200
4200
5200
6200
7200
8200
9200
10200
11200
Oct
-90
Mar
-91
Aug
-91
Jan-
92
Jun-
92
Nov
-92
Ap
r-93
Se
p-9
3 Fe
b-9
4 Ju
l-94
D
ec-9
4 M
ay-9
5 O
ct-9
5 M
ar-9
6 A
ug-9
6
Dow Jones Index (US) “How do we know when irrational exuberance has unduly escalated asset values?”
Alan Greenspan (Chairman US Federal Reserve)
December 6, 1996
How long can imbalances persist?
Macroeconomics in the Global Economy Antonio Fatás
0
2000
4000
6000
8000
10000
12000
Oct
-90
Ap
r-91
O
ct-9
1 A
pr-
92
Oct
-92
Ap
r-93
O
ct-9
3 A
pr-
94
Oct
-94
Ap
r-95
O
ct-9
5 A
pr-
96
Oct
-96
Ap
r-97
O
ct-9
7 A
pr-
98
Oct
-98
Ap
r-99
Dow Jones Index
How long can imbalances persist?
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Macroeconomics in the Global Economy Antonio Fatás
2200
3700
5200
6700
8200
9700
11200
12700
Oct
-90
Jun-
91
Feb
-92
Oct
-92
Jun-
93
Feb
-94
Oct
-94
Jun-
95
Feb
-96
Oct
-96
Jun-
97
Feb
-98
Oct
-98
Jun-
99
Feb
-00
Oct
-00
Jun-
01
Feb
-02
Oct
-02
Jun-
03
Feb
-04
Oct
-04
Jun-
05
Feb
-06
Oct
-06
Jun-
07
Feb
-08
Oct
-08
Jun-
09
Feb
-10
Oct
-10
Jun-
11
Feb
-12
Dow Jones Index
How long can imbalances persist?
Macroeconomics in the Global Economy Antonio Fatás
0
5
10
15
20
25
30
35
40
45
50
1860 1880 1900 1920 1940 1960 1980 2000 2020
Pric
e-E
arni
ngs
Rat
io (
CA
PE)
Year
US Stock Market Price-Earnings Ratio
1901 1966
2000
1981
1921
1929
22.02
Source: Robert Shiller
How long can imbalances persist?
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Macroeconomics in the Global Economy Antonio Fatás
50
70
90
110
130
150
170
190
210
1880 1900 1920 1940 1960 1980 2000 2020
Ind
ex 1
890=
100
Year
House Prices (US) adjusted for Inflation
Source: Robert Shiller
How long can imbalances persist?
Macroeconomics in the Global Economy Antonio Fatás
November 17th 2009, CNBC:
“While not being comfortable with the current gold trade, Dennis Gartman, founder of The Gartman Letter, told CNBC Monday that the price of the precious metal will “continue to go up until it stops …It is a gold bubble,” Gartman told CNBC. He called the trade on gold “mind boggling,” but also said he is currently long — or betting gold will go higher.”
The difficulty of predicting how long imbalances can persist
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Macroeconomics in the Global Economy Antonio Fatás
Summary of Business Cycles
v Business cycles are characterized by co-movements of a large number of macroeconomic series.
v On the basis of these movements we determine the state of the cycle – recessions, expansions, and the turning points.
v The nature of the business cycle has changed over time – in the 1980-2007 period recessions were shorter and milder and expansions are longer than fifty years ago.
v A possible candidate to explain business cycles isexogenous shocks. These shocks are transmitted throughout the economy by various propagation mechanisms.
v An alternative view is that we build imbalances over time until a correction is needed.
Macroeconomics in the Global Economy Antonio Fatás
Characterizing Labor Markets
v The utilization of labor resources can be summarized with the following variables: – Participation rate: It measures how active the working-age
population is. Some times discouraged unemployed will not appear in the statistics on unemployment but will show up as out of the labor force
– Unemployment rate (=100-Employment rate). It measures the % of active workers who do not have a job
– Number of hours worked. A measure of the intensity of effort for those who have a job (also reflects the part-time/full-time choices)
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Macroeconomics in the Global Economy Antonio Fatás
Labor Market Statistics: France (2010)
Working Age 65%
Not working
age 35%
Labor force 70%
Not in Labor force 30%
Employed 90.8%
Population: 64.9m
Working age (15-64): 42.1m
Labor force: 29.9m
Unemployed 9.2%
Macroeconomics in the Global Economy Antonio Fatás
Assignment
68
68
69
69
72
63
65
67
64
64
68
65
67
74
65
58 60 62 64 66 68 70 72 74 76
Australia Brazil
Bulgaria Canada
China Egypt
France Greece
India Japan
Lebanon Mexico
New Zealand Singapore
South Africa
Working-Age Population as % of Total
2010
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Macroeconomics in the Global Economy Antonio Fatás
Assignment
66
70
54
67
74
49
56
55
56
60
46
62
68
67
52
0 10 20 30 40 50 60 70 80
Australia Brazil
Bulgaria Canada
China Egypt
France Greece
India Japan
Lebanon Mexico
New Zealand Singapore
South Africa
Labor Force Participation
2008
Macroeconomics in the Global Economy Antonio Fatás
Assignment
5.6 8.3
6.8 8.3
4.3 9.4
9.1 9.5
4.4 5.0
9.0 5.2
6.1 5.9
23.8
0 5 10 15 20 25
Australia Brazil
Bulgaria Canada
China Egypt
France Greece
India Japan
Lebanon Mexico
New Zealand Singapore
South Africa
Unemployment
2008 (India for 2004)
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Macroeconomics in the Global Economy Antonio Fatás
Male Female
1973 2008 1973 2010
USA 89.7 83.3 52.9 71.4
EU15 82.5 80.8 38.3 66.9
0 20 40 60 80 100
15-24
25-54
55-64
65-69
Employment to Population (2010)
EU15 USA
30
40
50
60
70
80
US France
1975 2010
Age 55-64 Employment (to Population) Rate
A detailed analysis of labor force participation rates in Europe reveals very different patterns. Some European countries display lower participation rates especially for older and younger workers.
Labor Force Participation
Differences in Labor Markets
Macroeconomics in the Global Economy Antonio Fatás
Differences in Labor Markets: Europe versus the US
1,400
1,500
1,600
1,700
1,800
1,900
2,000
2,100
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
France Germany USA
Average Number of Hours per Year
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Macroeconomics in the Global Economy Antonio Fatás
59 61 63 65 67 69 71 73 75
1990
19
91
1992
19
93
1994
19
95
1996
19
97
1998
19
99
2000
20
01
2002
20
03
2004
20
05
2006
20
07
2008
20
09
2010
Ages 15-64
USA EU15
73
75
77
79
81
83
1990
19
91
1992
19
93
1994
19
95
1996
19
97
1998
19
99
2000
20
01
2002
20
03
2004
20
05
2006
20
07
2008
20
09
2010
Age 35-44
USA EU15
3
5
7
9
11
13
15
17
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Age 65+
USA EU15
The US Labor Market and the Current Crisis Employment to Population Ratio
The destruction of employment in the US during the current crisis has been much larger than in previous. As a result Europe has caught up with the US along some labor market dimensions.
Macroeconomics in the Global Economy Antonio Fatás
Differences in Labor Markets
Total Male Female
United States 70.9 76.4 65.5
Japan 70.7 81.6 59.7
France 64.6 69.2 60.1
Poland 59.2 66.3 52.4
Mexico 59.9 80.7 41.4
Korea 63.8 74.4 53.2
Sweden 75.7 78.1 73.2
Turkey 44.9 66.6 23.5
Employment to Working-Age Population Ratio (2008)
There are large differences in the level of activity in labor markets across countries. Emerging markets tend to have lower employment to population ratios, more so for female workers.
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Macroeconomics in the Global Economy Antonio Fatás
Unemployment
v Unemployment is the most common definition of the slack in the labor market. It is measured as the number of unemployed divided by the labor force. From a conceptual point of view, it is useful to distinguish between:
– Cyclical unemployment: Unemployment that responds to changes in the business cycle. Unemployment increases during recessions and decreases during booms.
– Natural Rate of Unemployment (structural unemployment): This is the unemployment that originates in the fact that “full employment” is impossible. There are always workers in a transition from one job to another. This unemployment is related to the structure and functioning of the labor market, the search process.
Macroeconomics in the Global Economy Antonio Fatás
What is the Natural Rate of Unemployment?
v There are flows out of employment – Sectoral or geographical shifts
Changes in the composition of demand Technological changes
– Bad matches between companies and workers
v It takes time to find a job once unemployed because of – Search – Frictional unemployment – Rigidities (for example, wage rigidities, minimum wages, taxes on
labor) – Structural unemployment
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Macroeconomics in the Global Economy Antonio Fatás
0
2
4
6
8
10
12
% o
f lab
or fo
rce
Unemployment Rate
Natural Rate of Unemployment
Cyclical Unemployment
The Natural Rate of Unemployment (U.S.)
?
Macroeconomics in the Global Economy Antonio Fatás
0
2
4
6
8
10
12
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
Unemployment Rate (% of Labor force)
Euro Countries
United States
Japan
A comparison between Europe, Japan and the US illustrates how different labor market institutions can lead to differences in performance: Since early 80’s, the EU has suffered from high rates of unemployment. Some of it has been labelled as structural.
Labor Markets: Unemployment
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Macroeconomics in the Global Economy Antonio Fatás
Summary of Labor Markets
v In the absence of rigidities, real wage and employment in the economy is determined by labor supply factors and labor demand.
v Labor demand is determined by the real wage, productivity and the
availability of capital. v The supply of labor is affected by the real wage, demographics,
participation rate, wealth, taxes, and the expected future wage. v The natural rate of unemployment characterizes the long-run
equilibrium rate of unemployment and is affected by the job search process and structural rigidities.
v Cyclical unemployment is the result of Business cycles.
Macroeconomics in the Global Economy Antonio Fatás
J63-70 J71-80
J81-90
J91-00
US63-70
US71-80
US81-90
US91-00
EU63-70
EU71-80
EU81-90
EU91-00
J01-05 US01-05
EU01-05
0
1
2
3
4
5
6
7
8
9
10
0 1 2 3 4 5 6 7 8 9 10
Une
mp
loym
ent R
ate
Productivity Growth
(*) Productivity is measured as labor productivity of the business sector. All data are averages over the years indicated in the labels. J stands for Japan, US for the United States and EU for European Union
There is no reason why technological progress should lead to unemployment (in fact the evidence shows the opposite correlation). This is only true under the (false) assumption that the number of jobs is limited or that there is a limit to how fast GDP can grow. Both of these variables (number of jobs and GDP growth) are endogenous!
Appendix: Does Technological Progress Lead to Unemployment?
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Macroeconomics in the Global Economy Antonio Fatás
Appendix: Great Moderation
v After inflation was brought down in the early 80s, we entered a period of stability in both inflation and growth rates known as “The Great Moderation”.
v The Great Moderation was the result of improved policies and an element of luck (absence of major economic shocks).
Macroeconomics in the Global Economy Antonio Fatás
0
2
4
6
8
10
12
14
16
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
1965 1970 1974 1978 1982 1987 1991 1995 1999 2004 2008
Inflation Volatility Growth Volatility Inflation
Appendix: The Great Moderation, US
Vol
atili
ty Inflation
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Macroeconomics in the Global Economy Antonio Fatás
0
2
4
6
8
10
12
14
16
0
0.5
1
1.5
2
2.5
3
3.5
4
1965 1969 1974 1978 1982 1986 1991 1995 1999 2003 2008
Inflation Volatility Growth Volatility Inflation
Appendix: The Great Moderation, France V
olat
ility
Inflation
Macroeconomics in the Global Economy Antonio Fatás
-2
0
2
4
6
8
10
12
14
16
18
20
0
1
2
3
4
5
6
7
8
9
10
1965 1970 1974 1978 1982 1987 1991 1995 1999 2004 2008
Inflation Volatility Growth Volatility Inflation
Appendix: The Great Moderation, New Zealand
Vol
atili
ty Inflation